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UBS Investment Research
Asia Oil and Chemicals
Alpha Preferences
Add Siam Cement & Nanya Plastics to Most Preferred
We add Siam Cement and NYP to our most preferred list. We like Siam Cement
for its solid mid-term earnings outlook (20% CAGR 2012E-13E) and potential
increase in near-term dividend, which we think could be a key positive catalyst in
2011. For NYP, we are positive on the company’s Q111 earnings outlook given its
leading position in MEG and polyester fiber production in the market.
Remove Formosa Chemicals & Fibre from Most Preferred
We remove FCFC from the most preferred list as share price has risen by 20% over
the past three months, outperforming other three Formosa Group companies in
Taiwan. We have switched to NYP for near-term most preferred in Taiwan. And
we keep FPCC as our least preferred name in Taiwan.
Add PTT Chemical to Least Preferred
We add PTT Chemical to our least preferred list as we see potential overhang for
the stock in the near-term including (1) potential merger with other PTT Group
companies in H111, (2) the block-out period for Siam Cement to sell their stakes
on PTT Chemical (4.4%) will end in the first week of March, (3) polyethylene
spreads likely to remain weak in the near-term given excess supply in the market.
Most Preferred
Essar Oil (ESRO.BO)
Buy
We are positive on Essar Oil based on: 1) stock underperformance—the stock has fallen from
its peak at the beginning of November; 2) the upgrade and expansion of its refinery, which
should provide substantial earnings upside; and 3) upside potential from retail price
deregulation. Expectations are generally low as Essar has a history of project delays. The
Essar refinery upgrade (Nelson complexity to increase from 6.1 to 11.8 by mid-2011) is
critical in driving stock performance. Our recent visit to Vadinar makes us confident that the
timeline will be met as will the commercial production of coal bed methane at Raniganj (this
is small but significant in proving execution capability).
— Valuation: We base our price target on a sum-of-parts based valuation. We value
refinery + retail + upstream, core refining at Rs140/share, retail at Rs17/share, and
upstream assets at Rs18/share. We estimate retail has additional potential of Rs5-
7/share and upstream Rs7-12/share if projects come on line as scheduled.
— Risk: Oil prices, refining margins and petrochemical spreads are highly seasonal,
which can sometimes lead to volatile earnings in the sector from quarter to quarter.
For India, government regulatory changes affect the oil sector.
PetroChina (0857.HK)
Buy
PetroChina is our preferred pick among oil stocks in China. The stock has been a major
underperformer in 2010 following consensus EPS downgrades. We believe the 12th five-year
plan in March, a potential upstream gas price hike by mid-2011, and major progress on
China’s unconventional gas development (CBM and shale gas) could all act as catalysts for
PetroChina in 2011.
— Valuation: We base our price target on a sum-of-the-parts methodology. We value
the E&P business on DCF (9.1% WACC and a US$85/bbl long-term Brent crude oil
price), and value the downstream business segments using EV/EBITDA multiples.
— Risk: In China, we believe government intervention in the event of a material spike
in global oil prices is a key risk. Government intervention can include policies related
to, for example, downstream refined product price caps or upstream oil windfall
profit taxes. Oil prices, refining margins and petrochemical spreads can be volatile,
highly cyclical and seasonal in nature.
Siam Cement (SCC.BK)
Buy
Siam Cement is our preferred pick in Thailand Oil & Chemicals sector. We like Siam
Cement for its solid mid-term earnings outlook (20% CAGR 2012E-13E) and potential
increase in near-term dividend, which we think could be a key positive catalyst in 2011. SCC
has a large amount of cash (14% of market cap), strong FCF yield (9-10% in 2011-12E), and
look to balance capital management between new project investment and cash return to
shareholders. We believe core-chemical profit is poised to benefit from the multi-year
recovery of polyolefin spreads. Meanwhile, volume growth at chemical associates (8%
CAGR 2011-12E), resilient PP-Naphtha margin, and strategy to increase high-value products
should sustain moderate earnings growth in the near-term (10% in 2011E).
— Valuation: We base our price target on a sum-of-the-parts methodology. We value
the E&P business on DCF (9.1% WACC and a US$85/bbl long-term Brent crude oil
price), and value the downstream business segments using EV/EBITDA multiples.
— Risk: We believe significant increase in coal price could put pressure on margins of
the cement business. Nonetheless, we think the potential improvement in domestic
cement price and volume should mitigate the margin pressure impact from rising fuel
costs.
Sinotech (CTE.O)
Buy
We re-iterate our Buy rating on SinoTech Energy (SinoTech), which provides enhanced oil
recovery (EOR) services in China. The company is taking advantage of the Chinese oil
majors’ increasing need to improve the output from their ageing oil fields. Its two key
services are: 1) lateral hydraulic drilling (LHD); and 2) EOR solutions that utilise a molecular
deposition film (MDF) technology. We think the key potential catalysts for SinoTech’s share
price are: 1) strong earnings growth; 2) an accelerated delivery of LHD units to China; 3)
additional visibility on its letters of intent (LOI) for additional LHD units; and 4) capacity
expansion by its supplier Jet Drill Well Services (Jet Drill).
— Valuation: SinoTech is trading at 13x FY11E pre-ex PE and 1.3x FY11E P/BV. This
compares to our forecast of an average 18% ROE (FY11-13). Its EV/EBITDA is 3.9x
FY12E. We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool. We assume a 10.6%
WACC.
— Risk: We think the risks to SinoTech’s businesses are: 1) single supplier risk for
LHD; 2) execution; 3) oil prices; 4) relationship with customers, including CNPC
and Sinopec (high customer concentration); 5) any loss of exclusivity and patents—
this would create increased competition for the company; 6) if its serviced
technologies becomes obsolete; and 7) replacement by alternative energy sources.
Nan Ya Plastics (1303.TW)
Buy
We add NYP to our most preferred names given (1) NYP is one of the largest MEG
producers in Asia, and MEG spreads have expanded from around US$190/ton level in Q310
to US$320/ton in Q410 and further up to almost US$400/ton in the first two weeks of
January. (2) NYP is one of the major polyester fiber producers in Asia and the company plans
to hike prices more after Chinese New Year holidays on the back of record high cotton prices
(3) Q111 earnings should be strong versus Q410 as the company comes out of its
maintenance shutdowns in Q410 (4) the stock has lagged other Formosa companies in Taiwan
in terms of share performance in the past three months.
— Valuation: Our price target of NT$84 is based on our sum-of-the-parts NAV
estimates, which translates to 14x 2011E PE and is 12% above the current share
price. The implied PE is also inline with its 10-year historical average PE.
— Risk: Petrochemical spreads are affected by the industry cycle, which is driven by
the balance of industry supply and demand. Major risks are weaker-than-expected
demand from China and a slower-than-expected macro recovery in the developed
economies and unexpected operating issues that can translate to short-term support
for chemical pricing in the market.
Least Preferred
Bharat Petroleum Corporation (BPCL.BO)
Sell
We think upside from deregulation is reflected in the share price, which has risen sharply
since the Government of India announced deregulation of gasoline in June. We think there are
no further triggers for the stock. The stock trades at a substantial premium to domestic peers
HPCL and IOC on reports of its upstream success overseas, as well as the commissioning of
its Bina refinery. We believe the market is overpricing these two events; in the case of the
latter peers HPCL and IOC also have new refineries lined up for 2011 and 2012.
— Valuation: We base our price target on 1.55x P/BV (20% premium to 2005-10
average). We think the stock is expensive relative to its peers on all parameters,
including PE, EV/EBITDA and P/BV. Deregulation is a key driver, but we believe
this is priced in and HPCL and IOC provide better exposure given their more
attractive valuation. Given recent performance, current valuation and high
expectations, we think there is downside risk to BPCL’s stock price.
— Risk: Oil prices, refining margins and petrochemical spreads are highly seasonal,
which can sometimes lead to volatile earnings in the sector from quarter to quarter.
For India, government regulatory changes affect the oil sector.
China National Offshore Oil Corporation (0883.HK)
Neutral
Given limited potential upside to our new price target, we maintain our Neutral rating on
CNOOC. We believe the stock looks unappealing at its current record high share price. The
stock is trading at a trailing EV/boe proven reserve of US$41/boe. Our top pick among China
oil and gas stocks is PetroChina (Buy).
— Valuation: We use a DCF valuation methodology that assumes a long-term Brent
crude oil price of US$85/bbl. Our WACC is 9.1%.
— Risk: In China, we believe government intervention in the event of a material spike
in global oil prices is a key risk. Government intervention can include policies related
to, for example, downstream refined product price caps or upstream oil windfall
profit taxes. Oil prices, refining margins and petrochemical spreads can be volatile,
highly cyclical and seasonal in nature.
Formosa Petrochemical Corporation (6505.TW)
Neutral
We believe Formosa Petrochemical’s current valuation is not attractive because of: 1) limited
earnings upside in 2011 as its refining utilisation rate is likely to remain at around 80%; and
2) it has to wait six to nine months for the delivery of new RDS components (which were
seriously damaged in the fire in July). In addition, we are less bullish on upstream olefin
spreads, not downstream petrochemicals.
— Valuation: We derive our price target of NT$86.00 from a DCF-based methodology
and explicitly forecast long-term valuation drivers with UBS’s VCAM tool. Our
price target translates to 23x 2011E PE and implies limited upside from the current
share price level.
— Risk: Petrochemical spreads are affected by the industry cycle, which is driven by
the balance of industry supply and demand. Major risks are weaker-than-expected
demand from China and a slower-than-expected macro recovery in the developed
economies and unexpected operating issues that can translate to short-term support
for chemical pricing in the market.
PTT Chemical (PTTC.BK)
Neutral
We maintain our Neutral stance on PTT Chemical as we see potential overhang for the stock
in the near-term including (1) potential merger with other PTT Group companies in H111 (2)
the block-out period for Siam Cement to sell their stakes on PTT Chemical (4.4%) will end in
the first week of March (3) polyethylene spreads likely to remain weak in the near-term given
excess supply in the market.
— Valuation: We drive our Bt165 price target from a DCF-based methodology and
explicitly forecast long-term valuation drivers with UBS’s VCAM tool. Our price
target translates to 13.8x 2011E PE.
— Risk: Petrochemical spreads are affected by the industry cycle, which is driven by
the balance of industry supply and demand. Major risks are weaker-than-expected
demand from China and a slower-than-expected macro recovery in the developed
economies and unexpected operating issues that can translate to short-term support
for chemical pricing in the market.
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